Iran: Closing Hormuz Strait to Deal With EU's Embargo?

Iranian authorities have reacted to the decision by the European Union on an embargo by calling for an immediate halt to oil sales to the continent. In a statement on its website, the Iranian Oil Ministry described the European Union’s decision as “hasty” and “a political game”.

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This satellite image shows the Strait of Hormuz, between the Persian Gulf and the Gulf of Oman. The Strait of Hormuz runs between Iran and United Arab Emirates.

But a spokesman for the parliament’s energy committee also told the semi-official Fars news agency that the country still saw the closure of the Strait of Hormuz as one of the strategies to deal with an oil embargo.

The agreement by the EU includes a ban on all new contracts to import, buy or transport Iranian crude, a freeze of the country’s central bank assets, and a ban on all trade in precious metals. Countries have until July 1st to take the necessary measures.

The Oil Ministry also rejected speculation the country would struggle to find new customers to replace its sizeable EU clientele, saying it would be done “easily”.

Still, market observers believe that widening sanctions will force Iran to eventually offer its crude at a discount. But as of Tuesday, official selling prices (OSP) did not to reflect changes to that effect.

The European Union accounted for more than 500,000 barrels per day of Iran’s exports, and is now likely to look for alternative supplies from Saudi Arabia, Russia or Iraq for the predominately heavy crude oil.

Iran’s existing trade relationships will come under renewed pressure after state-owned Bank Tejarat was also added to the blacklist, with the EU saying that the bank was facilitating Iran’s nuclear efforts. The bank originally had six branches abroad, including France, China, Germany, UK, the UAE and Tajikistan.

Rising Geopolitical Risk

A spokesperson for the bank’s branch in Dubai, which is registered under the name Persia Bank International PLC, confirmed to CNBC that previous sanctions had already derailed operations there and that “no transactions have been taking place” since last year.

Dubai enjoys a lucrative trade relationship with Iran, primarily focusing on re-export, reaching as much as $12 billion in 2007. In a report by the Carnegie Endowment for International Peace last year, the UAE was described as “Tehran’s most important connection to the global economy”.

Meanwhile, a report by Fitch Ratings argued that the latest embargo by the European Union would increase the geopolitical risk in the Middle East.

The report added that the prospect of diminishing spare capacity in Saudi Arabia, should the Kingdom once again live up to its promise of ensuring sufficient supply in the market, could “send oil prices much higher than their current level”.

The extent of spare capacity depletion is likely to depend on whether Iran’s customers in Asia, such as India and China, decide to follow suit with a substantial reduction of crude imports.

Indeed, Petromatrix underscored in a research note on Tuesday that the US/EU embargo would make OPEC less effective and “will put a greater burden on Saudi Arabia”. The total production capacity of the Kingdom stands officially at 12.5 million barrels per day.

The latest figures by the Joint Organizations Data Initiative (JODI) for November would suggest a spare capacity of 2.03 million barrels per day. The tightening economic noose is meant to force a shift in Iran’s nuclear policy. The country maintains it is pursuing a peaceful program.